Controlling the Fiscal Costs of Banking Crises

34 Pages Posted: 13 Sep 2001

See all articles by Patrick Honohan

Patrick Honohan

Independent; Trinity College Dublin - Department of Economics; Peter G. Peterson Institute for International Economics; Centre for Economic Policy Research (CEPR)

Daniela Klingebiel

World Bank - Policy Unit

Date Written: September 2000

Abstract

Certain measures add greatly to the fiscal cost of banking crises: unlimited deposit guarantees, open-ended liquidity support, repeated recapitalization, debtor bail-outs, and regulatory forbearance. The findings in this paper tilt the balance in favor of a strict rather than an accommodating approach to crisis resolution.

In recent decades, a majority of countries have experienced a systemic banking crisis requiring a major-and expensive-overhaul of their banking system. Not only do banking crises hit the budget with outlays that must be absorbed by higher taxes (or spending cuts), but they are costly in terms of forgone economic output.

Many different policy recommendations have been made for limiting the cost of crises, but there has been little systematic effort to see which recommendations work in practice. Honohan and Klingebiel try to quantify the extent to which fiscal outlays incurred in resolving banking distress can be attributed to crisis management measures of a particular kind adopted by the government in the early years of the crisis.

They find evidence that certain crisis management strategies appear to add greatly to fiscal costs: unlimited deposit guarantees, open-ended liquidity support, repeated recapitalization, debtor bail-outs, and regulatory forbearance.

Their findings clearly tilt the balance in favor of a strict rather than an accommodating approach to crisis resolution. At the very least, regulatory authorities who choose an accommodating or gradualist approach to an emerging crisis must be sure they have some other way to control risk-taking.

This paper - a product of Finance, Development Research Group, and Financial Sector Strategy and Policy Department - is part of a larger effort in the Bank to examine the effects of financial sector regulation. The authors may be contacted at phonohan@worldbank.org or dklingebiel@worldbank.org.

JEL Classification: H60, G2, G33

Suggested Citation

Honohan, Patrick and Honohan, Patrick and Klingebiel, Daniela, Controlling the Fiscal Costs of Banking Crises (September 2000). Available at SSRN: https://ssrn.com/abstract=282514

Patrick Honohan

Trinity College Dublin - Department of Economics ( email )

Dublin 2
Ireland

Independent ( email )

11 Cowper Gardens
+353 1 4979222 (Phone)

Peter G. Peterson Institute for International Economics ( email )

1750 Massachusetts Avenue, NW
Washington, DC 20036
United States

Centre for Economic Policy Research (CEPR)

33 Great Sutton St,
Clerkenwell,
London, EC1V 0DX
United Kingdom

Daniela Klingebiel (Contact Author)

World Bank - Policy Unit ( email )

1818 H Street NW
Room MC 9-903
Washington, DC 20433
United States
202-473-7470 (Phone)
202-522-2031 (Fax)

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